Close it for a nice profit, hold it, or adjust?

J

JJacksET4

As I expected it to be difficult for the markets to move up substantially at that time, on May 18th, I did basically a Ratio Call Spread on SPY, the only thing being since I can't really have extra uncovered short Calls, I bought farther OTM Calls to protect those shorts. I like a trade like this because it only gets hurt in a decent upward market move, in which case my mutual funds, 401K, etc. do good anyways.

I am looking for thoughts on this trade assuming todays closing prices approximately held up on Monday or at some point next week.

Here was the situation when I did the trade (May 18th):

SPY Close (not sure what the exact price was when trades were done):
134.36
Here was the trade
+6 136 C Aug - $304 cost = $1824
-12 138 C Aug - $212 credit = $2544
+6 146 C Aug - $30 cost = $180
Total Credits = $540.00

Current Situation:
SPY = 130.42 (for values below I went between bid/ask)
+6 136 C Aug - $116 value = $696
-12 138 C Aug - $70 value = $840
+6 146 C Aug - $6 value = $36

Value against me (or cost to close) = $108

Profit to close now = $442, which is a good return on investment considering the time has only been 1/2 month).

Another option is to hold, considering this position would only get into trouble at least nearing expiration with SPY>$138 and really up to around $140, which seems very unlikely now of course.

What I am wondering is if anyone has creative ideas for adjustments to maintain future profit potential while capping risk even more, but that costs very little now? For example, I could roll the 146 Calls down, maybe to 142/143? for a low cost, but is that even worth it? I could buy some July calls, but that only stops risk through July expiration, etc?

Now that I am typing this up, I am thinking just closing is the best course of action - to lock in the profits in such a small period of time.

What do you guys think?

JJacksET4
 
Quote from JJacksET4:

What I am wondering is if anyone has creative ideas for adjustments to maintain future profit potential while capping risk even more, but that costs very little now? For example, I could roll the 146 Calls down, maybe to 142/143? for a low cost, but is that even worth it? I could buy some July calls, but that only stops risk through July expiration, etc?

Now that I am typing this up, I am thinking just closing is the best course of action - to lock in the profits in such a small period of time.
More...
There's no such animal (something that allows for future profit, costs little and caps risk). For the $108 of potential profit left in the position and given that expiration is August, best thing to do is probably close it.

Now if you were bearish here, you could roll the -12 Aug 136c's down 2-3 pts (and do 1/2 as many). That would bring in 3-5 hundred $ more and convert to a bearish vertical - ignoring the near worthless 46c's. You could cash them in but for a nickel, I'd keep them as a lottery ticket or as a protective leg for a similar position should you close now, get a reversal and put on another similar position.
 
JJacks

Good questions, and they show you are really considering risks properly.

My first thought is that you probably should close. After all, if you don't change your position, you will have to wait until the third week of August to collect the entire $108.00. You also run a small risk that the market could turn back up and ruin your position (although the logic of having your mutual funds gain indicates this is somewhat of a hedge, anyway).

The next thought is what do you think the market is going to do?

If you think it will continue to drop, you could close the current position and do a similar position at lower levels, perhaps moving all the positions down 3 or 4 points giving you more hedging of your mutual fund position. Another suggestion is to use the SPX and just do a 1-2-1 saving some commissions (Although the size is a bit bigger than you are doing with SPY, you don't run the risk of winding up owning shares which may be a nuisance you don't want).

If you think the market might recover (QE#3....) , then Spin's suggestion to roll down the central strikes and reduce the amount to 6 (and keep the upper strikes as a cheap lottery ticket) is another good idea which would allow you to collect more cash without adding more risk. The other way to completely free your margin is to move the top leg down to balance the butterfly again and completely remove all risk of losses-- freeing your margin for other uses.

Whatever you do, it is usually best make sure you collect at least some of the profit!

By the way, this position is usually called a broken wing butterfly these days, and they often work quite well. With your mutual fund portfolio, you have a good hedge against the moderate upside risk related to upper section of the broken wing.

Happy trading!
 
Buy the Aug 140/146 call vertical 6 times for about .31 ($186), creating a risk-free 136/38/40 butterfly, i.e. a butterfly with a guaranteed minimum profit of $256 ($446 unrealized profit - $186).

While the probability of hitting your current maximum loss of about $3000 is low, you cannot ignore it. For $186, you completely eliminate all risk, lock in a nice profit, free up margin, and have the same max profit should the market rally to 138 near expiration.
 
JJacks,

weewilly has just told you exactly how to implement my suggestion about balancing the butterfly again and freeing the margin (taking away all risk of loss), and shown you how to take home cash by providing the current prices to do the rebalancing.

Looks good to me.
 
weewilly and John Green,

Thanks for the posts. I hadn't considered my position as a Broken Wing Butterfly, but I guess it is!

My general view on the market is that a short term rebound wouldn't surprise me, but I don't see SPY getting over 140 by Aug either. I do agree that any possible risk should be taken seriously, as I am a limit/reduce risk first type trader.

The suggestion to buy 140s and sell the 146s to get a free no-risk butterfly is certainly a great idea to consider.

I think tomorrow or very soon, I will either just close the position entirely or do that adjustment.

Thanks,

JJacksET4
 
Another way to look to at the problem is to ask "Would I put this position on today at these prices?" If you view (dissect) your original position as a 136/38/40 butterfly plus a short 140/146 vertical, you can ask the questions:

1) Would I put on the 136/38/40 butterfly today for (a nice credit)? Answer: Yes, as many times as possible.

2) Would I sell the 140/146 vertical for .31 today? Answer: risk/reward of 17:1 is _terrible_. No, this vertical is too cheap to hold short.

Read Cottle to brush up on position dissection.
 
1) No one ever went broke taking a profit. There's a reason for that old saying.

2) You may be misjudging your future rate of return. Fairly common, I think. Example:

* buy sumpin' for $100.

* it goes up to $200. What's your rate of return? Duh, 100%, right?
- YES

* you hang onto it and it goes up from $200 to $300(yowzir; ain't you smart).
What's your rate of return? Duh, 300%, right?
- WRONGO.

Your -actual- rate of return on the 2nd move is 50%, cuz the position was -then- currently worth $200. $200 --> $300 = 50% rate of return.

Ala the above post about 'would you open this position NOW, at these price points?'.

When viewed this way, the first move of 100% is not only a great return, but it becomes much clearer that -any- further appreciation in your position is much punier than having it fade away from you.

Translation: if you have a nice return in a position, either close it out or take enough $$$ off the table to -guarantee- that you'll either not lose money on the original position or that(better yet), you'll eek out a small, but reasonable profit if it starts slipping away from you.

Btw, hanging on too long and watching is slip away from you really screws up your psychology and just makes it mentally that much harder the next time.
 
Quote from AMA:

2) You may be misjudging your future rate of return. Fairly common, I think. Example:

* buy sumpin' for $100.

* it goes up to $200. What's your rate of return? Duh, 100%, right?
- YES

* you hang onto it and it goes up from $200 to $300(yowzir; ain't you smart).
What's your rate of return? Duh, 300%, right?
- WRONGO.

Your -actual- rate of return on the 2nd move is 50%, cuz the position was -then- currently worth $200. $200 --> $300 = 50% rate of return.
More...
Clever but flawed logic. You first gain wasn't 100% because when the position was worth $150, it was up 50%. When it hit your $200 mark, the $50 of add'l profit was only a 33% gain.

:confused: :D :p
 
No, logic not flawed, just smoothed over for an example.

While you're right about $150 --> $200 being a 33% move, you have to be practical and realistic; especially for illustrative purposes.

It's actually a sliding scale as you move up...

One way(among many) ways to deal with this issue would be to scale your self back & out as the profits go up. Not quite as much pure profit, but less danger of losses, too.

Point being made was that once you have an acceptable profit(whatever that is), it's time to start locking it in a bit.
 
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